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Trade integration has been a central element of U.S.-Mexico relations for the past quarter century. The renegotiation of the North America Free Trade Agreement (NAFTA) presented a formidable challenge for two neighboring countries who also manage a complex border agenda including immigration and drug control. As President Trump considered terminating NAFTA and continues to press for the construction of a border wall, the risks of deteriorating bilateral relations increased. Against these odds, the NAFTA parties successfully concluded negotiations this fall. How were the United States and Mexico able to keep relations on an even keel in the midst of tough trade negotiations? What was accomplished or not in the newly baptized U.S.-Mexico-Canada trade agreement? How did other areas of the bilateral relation evolve during this period of uncertainty regarding the future of economic integration? What are the prospects for U.S.-Mexico relations going forward?

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Washington, DCpast15427242001542729600America/New_YorkTrade integration has been a central element of U.S.-Mexico relations for the past quarter century. The renegotiation of the North America Free Trade Agreement (NAFTA) presented a formidable challenge for two neighboring countries who also manage a complex border agenda including immigration and drug control. As President Trump considered terminating NAFTA and continues to press for the construction of a border wall, the risks of deteriorating bilateral relations increased. Against these odds, the NAFTA parties successfully concluded negotiations this fall. How were the United States and Mexico able to keep relations on an even keel in the midst of tough trade negotiations? What was accomplished or not in the newly baptized U.S.-Mexico-Canada trade agreement? How did other areas of the bilateral relation evolve during this period of uncertainty regarding the future of economic integration? What are the prospects for U.S.-Mexico relations going forward?
On November 20, Brookings Foreign Policy Senior Fellows Mireya Solís and Vanda Felbab-Brown engaged Mexico’s Ambassador to the United States Gerónimo Gutiérrez Fernández and Wilson Center Public Policy Fellow Earl Anthony “Tony” Wayne, who also served as former U.S. ambassador to Mexico and assistant secretary of state, in a discussion of the state of U.S.-Mexico relations at present and going forward. Trade integration has been a central element of U.S.-Mexico relations for the past quarter century. The renegotiation of the North America Free Trade Agreement (NAFTA) presented a formidable challenge for two neighboring countries who also manage a ... https://www.brookings.edu/blog/future-development/2018/11/05/should-governments-favor-small-firms-with-special-tax-regimes/Should governments favor small firms with special tax regimes?http://webfeeds.brookings.edu/~/578516882/0/brookingsrss/topics/mexico~Should-governments-favor-small-firms-with-special-tax-regimes/
Mon, 05 Nov 2018 15:17:58 +0000https://www.brookings.edu/?p=546241

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By Santiago Levy

Small firms are responsible for much of the job creation in Latin America. At times, they are considered repositories of entrepreneurial talent and innovation. For these and other reasons, governments deploy special policies to help them, like subsidized credits from development banks or set-aside purchases from the government. In Latin America, one policy stands out: special tax regimes with substantially lower tax burdens.

In Peru, for example, firms face four different social insurance and corporate tax regimes depending on their level of sales and number of employees; the tax burden gets larger as firms get bigger. In Brazil, small firms can jointly cover their social insurance and corporate tax obligations through a single payment if they are small, but separately and at higher rates if they are large. In Mexico, firms with sales below a certain threshold face a lower tax burden than firms with sales above it. In Costa Rica, small firms—as determined by a formula combining sales, purchases, assets, and employees—jointly pay their value added and income taxes through a single tax. Although eligibility requirements vary, as well the implicit subsidy, with the exceptions of exceptions of El Salvador, Panama, and Venezuela, every country in Latin America has some form of a special regime for small firms.

Despite their popularity, the objectives of these special tax regimes are not always clear. Is it to promote employment or entrepreneurship? Or is it to promote smallness for its own sake, despite the tendency for small firms to be much less productive than larger ones? Is it the hope that these firms will grow and become more productive?

Tilting against productivity

My view is that these special tax regimes may be counterproductive, because they allow low productivity firms to survive in the market and impede higher productivity firms from growing and creating more productive and better paying jobs. These regimes may be one reason why productivity in Latin America has grown so slowly.

To illustrate one of the main problems (see Table 1), assume that small and large firms are distinguished by their sales, the threshold separating them is 2 million pesos in annual sales, and firms are taxed at 2 percent of sales if they are small and 30 percent of profits if they are large. The first line depicts a firm with sales of 1 million pesos a year, paying 700,000 pesos in materials and wages. So profits before taxes are 300,000 pesos. Because sales are below the threshold, the firm pays 20,000 pesos in taxes (2 percent of 1 million) and makes 280,000 pesos in after-tax profits.

Note that in the absence of this special regime the firm would have paid 90,000 pesos in taxes (30 percent on gross profits of 300,000) and earned 210,000 pesos in after-tax profits. After-tax profits are 33 percent higher than they would have been had the firm not been favored.

Table 1: Hypothetical example of a firm taxed under a special and normal regime (pesos)

Gross Sales

Labor and Materials

Before Tax

Profits

Special Regime

Normal Regime

Tax

After Tax Profits

Tax

After Tax Profits

1,000,000

700,000

300,000

20,000

280,000

90,000

210,000

2,000,000

1,400,000

600,000

40,000

560,000

180,000

420,000

2,100,000

1,470,000

630,000

N.A.

N.A.

189,000

441,000

2,680,000

1,876,000

804,000

N.A.

N.A.

241,200

562,800

N.A. = Not an available option.

If sales double, the firm still qualifies for the special regime. In the second line of Table 1, the firm now makes gross profits of 600,000 pesos, pays 40,000 pesos in taxes, and makes 560,000 pesos in after-tax profits (again, 33 percent higher than the 420,000 in after-tax profits it would have made in the absence of the special regime). Since after-tax profits increase with sales, the firm has all the incentives to grow.

The problem begins after this point. If sales grew again, say, by 5 percent to 2,100,000 pesos, the firm would no longer qualify for the special regime. The third line of table 1 shows that the firm would have to pay 30 percent of its gross profits of 630,000 pesos in taxes, so its after-tax profits would fall to 441,000 pesos, less than what the firm was making before it grew (560,000 pesos). The firm is better off staying small. In fact, the firm will only grow if its sales increase by at least 34 percent, at which point after-tax profits (at 562,800 pesos) will be higher than under the special regime. And even if sales grow by more than a third, after-tax profits would barely increase by 0.5 percent.

More productive might mean less profitable

The problem is that a firm with sales of 1,999,999 pesos may be substantially less productive than a firm with sales of 2,000,001 pesos, but substantially more profitable. The less productive firm will survive in the market, and maybe even get bank credit—it is very profitable, after all—while the more productive firm may not survive.

This is a hypothetical example but the tax regime is real. This is what actually happens in Mexico. Figure 1 uses firm-level data from Mexico’s Economic Census for 2013 to show the effects of Mexico’s tax regime. As it turns out, there are 7,755 firms whose sales levels are 5 percent or less than the threshold established in Mexican law separating large from small firms. The figure plots the change in after-tax profits for each firm if sales increase by 10, 20, or 30 percent.

Figure 1: Changes in after-tax profits for “close to but below the threshold firms” (percentage change)

Amazingly, if sales increased by 10 percent, 88 percent of all firms under consideration would experience a drop in after-tax profits (point A in the figure). If sales increased by 20 percent, 80 percent of firms would experience lower after-tax profits (point B). Even if sales could increase by 30 percent, more than half of all firms would be better off not growing (point C).

Mexico is not alone

These problems are endemic. In Latin America, they are a big reason for the large number of small firms that characterize the region’s economies. The details of how these regimes operate vary from country to country, but the general effect is the same: inadvertently, these regimes allow unproductive firms to survive and impede productive firms from growing, exactly the opposite of what is needed to create well-paid jobs.

Tax policies are distorting the size distribution of firms. Smaller firms have higher entry and exit rates and can induce greater labor rotation, impeding learning on the job. These firms may be creating many jobs, but these jobs are both less stable and compromise wage growth.

Other things contribute to the overabundance of small and unproductive firms in Latin America, but special tax regimes are clearly culpable. Policymakers should be asking themselves whether favoring small firms with special regimes is the best way to create good jobs.

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https://www.brookings.edu/wp-content/uploads/2018/11/global_small-firm_001.jpg?w=270By Santiago Levy
Small firms are responsible for much of the job creation in Latin America. At times, they are considered repositories of entrepreneurial talent and innovation. For these and other reasons, governments deploy special policies to help them, like subsidized credits from development banks or set-aside purchases from the government. In Latin America, one policy stands out: special tax regimes with substantially lower tax burdens.
In Peru, for example, firms face four different social insurance and corporate tax regimes depending on their level of sales and number of employees; the tax burden gets larger as firms get bigger. In Brazil, small firms can jointly cover their social insurance and corporate tax obligations through a single payment if they are small, but separately and at higher rates if they are large. In Mexico, firms with sales below a certain threshold face a lower tax burden than firms with sales above it. In Costa Rica, small firms—as determined by a formula combining sales, purchases, assets, and employees—jointly pay their value added and income taxes through a single tax. Although eligibility requirements vary, as well the implicit subsidy, with the exceptions of exceptions of El Salvador, Panama, and Venezuela, every country in Latin America has some form of a special regime for small firms.
Despite their popularity, the objectives of these special tax regimes are not always clear. Is it to promote employment or entrepreneurship? Or is it to promote smallness for its own sake, despite the tendency for small firms to be much less productive than larger ones? Is it the hope that these firms will grow and become more productive?
Tilting against productivity
My view is that these special tax regimes may be counterproductive, because they allow low productivity firms to survive in the market and impede higher productivity firms from growing and creating more productive and better paying jobs. These regimes may be one reason why productivity in Latin America has grown so slowly.
To illustrate one of the main problems (see Table 1), assume that small and large firms are distinguished by their sales, the threshold separating them is 2 million pesos in annual sales, and firms are taxed at 2 percent of sales if they are small and 30 percent of profits if they are large. The first line depicts a firm with sales of 1 million pesos a year, paying 700,000 pesos in materials and wages. So profits before taxes are 300,000 pesos. Because sales are below the threshold, the firm pays 20,000 pesos in taxes (2 percent of 1 million) and makes 280,000 pesos in after-tax profits.
Note that in the absence of this special regime the firm would have paid 90,000 pesos in taxes (30 percent on gross profits of 300,000) and earned 210,000 pesos in after-tax profits. After-tax profits are 33 percent higher than they would have been had the firm not been favored.
Table 1: Hypothetical example of a firm taxed under a special and normal regime (pesos)
Gross Sales
Labor and Materials
Before Tax
Profits
Special Regime
Normal Regime
Tax
After Tax Profits
Tax
After Tax Profits
1,000,000
700,000
300,000
20,000
280,000
90,000
210,000
2,000,000
1,400,000
600,000
40,000
560,000
180,000
420,000
2,100,000
1,470,000
630,000
N.A.
N.A.
189,000
441,000
2,680,000
1,876,000
804,000
N.A.
N.A.
241,200
562,800
N.A. = Not an available option.
If sales double, the firm still qualifies for the special regime. In the second line of Table 1, the firm now makes gross profits of 600,000 pesos, pays 40,000 pesos in taxes, and makes 560,000 pesos in after-tax profits (again, 33 percent higher than the 420,000 in after-tax profits it would have made in the absence of the special regime). Since after-tax profits increase with sales, the firm has all the incentives ... By Santiago Levy
Small firms are responsible for much of the job creation in Latin America. At times, they are considered repositories of entrepreneurial talent and innovation. For these and other reasons, governments deploy special policies to ... https://www.brookings.edu/articles/mexicos-new-president-needs-a-better-solution-to-criminal-violence/Mexico’s new president needs a better solution to criminal violencehttp://webfeeds.brookings.edu/~/571735926/0/brookingsrss/topics/mexico~Mexico%e2%80%99s-new-president-needs-a-better-solution-to-criminal-violence/
Thu, 27 Sep 2018 20:29:48 +0000https://www.brookings.edu/?post_type=article&p=539555

Listen to Brookings podcasts here or on iTunes, send email feedback to bcp@brookings.edu, and follow us and tweet us at @policypodcasts on Twitter.

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By Geoffrey Gertz
Fellow Geoffrey Gertz discusses the recent NAFTA announcement by the United States and Mexico, and predicts how Canada is likely to respond.
Related content:
Why Mexico should not fear losing NAFTA’s investment rules
Why do Trump’s announced trade policies keep coming up empty?
Is Trump remaking American trade enforcement policy?
Listen to Brookings podcasts here or on iTunes, send email feedback to bcp@brookings.edu, and follow us and tweet us at @policypodcasts on Twitter.By Geoffrey Gertz
Fellow Geoffrey Gertz discusses the recent NAFTA announcement by the United States and Mexico, and predicts how Canada is likely to respond.https://www.brookings.edu/media-mentions/20180827-wall-street-journal-geoff-gertz/20180827 Wall Street Journal Geoff Gertzhttp://webfeeds.brookings.edu/~/566440284/0/brookingsrss/topics/mexico~Wall-Street-Journal-Geoff-Gertz/
Mon, 27 Aug 2018 15:17:54 +0000https://www.brookings.edu/?post_type=media-mention&p=534185

Why has an economy that has done so many things right failed to grow fast? Under-Rewarded Efforts traces Mexico’s disappointing growth to flawed microeconomic policies that have suppressed productivity growth and nullified the expected benefits of the country’s reform efforts. Fast growth will not occur doing more of the same or focusing on issues that may be key bottlenecks to productivity growth elsewhere, but not in Mexico. It will only result from inclusive institutions that effectively protect workers against risks, redistribute towards those in need, and simultaneously align entrepreneurs’ and workers’ incentives to raise productivity. For this transformation to take place, substantive changes to the country’s tax, labor, and social insurance regimes are required.

Santiago Levy, nonresident senior fellow in the Global Economy and Development program at Brookings, published this book with the Inter-American Development Bank.

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By Santiago Levy
Why has an economy that has done so many things right failed to grow fast? Under-Rewarded Efforts traces Mexico’s disappointing growth to flawed microeconomic policies that have suppressed productivity growth and nullified the expected benefits of the country’s reform efforts. Fast growth will not occur doing more of the same or focusing on issues that may be key bottlenecks to productivity growth elsewhere, but not in Mexico. It will only result from inclusive institutions that effectively protect workers against risks, redistribute towards those in need, and simultaneously align entrepreneurs’ and workers’ incentives to raise productivity. For this transformation to take place, substantive changes to the country’s tax, labor, and social insurance regimes are required.
Santiago Levy, nonresident senior fellow in the Global Economy and Development program at Brookings, published this book with the Inter-American Development Bank.
Learn more about the book and view the full PDF version in English or in Spanish. By Santiago Levy
Why has an economy that has done so many things right failed to grow fast? Under-Rewarded Efforts traces Mexico’s disappointing growth to flawed microeconomic policies that have suppressed productivity growth and nullified ... https://www.brookings.edu/blog/order-from-chaos/2018/07/05/with-a-new-president-in-power-whats-the-future-of-mexicos-much-needed-energy-reforms/With a new president in power, what’s the future of Mexico’s much-needed energy reforms?http://webfeeds.brookings.edu/~/556607816/0/brookingsrss/topics/mexico~With-a-new-president-in-power-what%e2%80%99s-the-future-of-Mexico%e2%80%99s-muchneeded-energy-reforms/
Thu, 05 Jul 2018 18:09:46 +0000https://www.brookings.edu/?p=526160

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By Samantha Gross

Mexicans, frustrated with years of increasing violence and corruption and sluggish economic growth, elected a new president on Sunday. Andrés Manuel López Obrador is a charismatic populist who won the presidency in a landslide, vowing to overthrow the “mafia of power” in Mexico. His election is concerning to international business interests in Mexico, particularly those in the oil and gas industry. Although he has softened his earlier strident views on Mexico’s energy reforms, he remains skeptical of the reforms’ benefits for Mexican citizens.

Oil Reforms were a big step for Mexico

President Enrique Peña Nieto assumed the presidency in 2012 amid a wave of optimism. He garnered sufficient support to amend the constitution to reform the Mexican energy sector, rolling back the state-owned monopolies that dominated oil, gas, and electricity production and supply.

One cannot overstate the importance of oil to Mexico. The day in 1938 when Mexico nationalized the oil industry is still celebrated as a national holiday and Mexicans consider the resource an important part of their national patrimony. But the country’s oil production has fallen in recent years, as the giant Cantarell field is in decline and a mismanaged and cash-poor Pemex, Mexico’s national oil company, has not invested enough to make up for the loss.

Since the reforms, the Mexican government has entered into oil and gas exploration contracts with nearly 80 companies. Contracts already in place under the reforms could yield $200 billion in investments in Mexico’s energy sector in the coming years. These investments will benefit Mexico’s economy and its people, but these benefits will take time to appear. Politicians and energy investments operate on different timeframes, and Peña Nieto will not see the fruits of his reform within his term.

In the meantime, Mexican citizens are skeptical of the reforms and most concerned about pocketbook issues—the prices for gasoline and electricity that they pay every day—as my Brookings colleagues recently explored in an excellent paper.

Will López Obrador retain the reforms?

In the past, President-elect López Obrador was strongly opposed to the energy reforms. In 2014, he led an effort to hold a binding national referendum to abolish the reforms, but the supreme court blocked the effort. Completely reversing the reforms would be another change to the constitution, requiring a two-thirds vote from both houses of congress and approval from a majority of the 32 state legislatures.

López Obrador has softened his opinion of the reforms since then. He has pulled back his promise to reverse them, instead stating that he will review all contracts established under the reforms to ensure that they are in Mexico’s national interest. Just before the election, his business advisor Alfonso Romo said that López Obrador was open to more contracts for oil and gas exploration if the process was not tainted by corruption. Romo also said that he was comfortable with the contracts that he had reviewed thus far.

Uncertainty is the biggest challenge to investment in Mexico’s oil and gas sector today.

Despite these reassurances, uncertainty is the biggest challenge to investment in Mexico’s oil and gas sector today. As López Obrador makes the transition from campaigning to governing, he will face pressures from many directions. It remains to be seen how he will balance business interests and economic growth against the demands of his populist base. The process of reviewing contracts for oil and gas development introduces uncertainty—López Obrador could bring the auction process for new exploration to a halt without changing any laws or the constitution, just by making the process too risky for investors.

I’m in Mexico now and have been watching the news and talking to people about the election. In my admittedly unscientific sample, people desperately wanted change and are pleased to have a democratically elected president from outside the two main parties. However, they are uncertain whether López Obrador will rule as the populist firebrand he has been in the past, or as a more practical and mature leader as some of his prominent supporters have claimed. Running on a platform of change is relatively easy. Implementing change in a balanced and careful way is much more difficult.

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By Samantha Gross
Mexicans, frustrated with years of increasing violence and corruption and sluggish economic growth, elected a new president on Sunday. Andrés Manuel López Obrador is a charismatic populist who won the presidency in a landslide, vowing to overthrow the “mafia of power” in Mexico. His election is concerning to international business interests in Mexico, particularly those in the oil and gas industry. Although he has softened his earlier strident views on Mexico’s energy reforms, he remains skeptical of the reforms’ benefits for Mexican citizens.
Oil Reforms were a big step for Mexico
President Enrique Peña Nieto assumed the presidency in 2012 amid a wave of optimism. He garnered sufficient support to amend the constitution to reform the Mexican energy sector, rolling back the state-owned monopolies that dominated oil, gas, and electricity production and supply.
One cannot overstate the importance of oil to Mexico. The day in 1938 when Mexico nationalized the oil industry is still celebrated as a national holiday and Mexicans consider the resource an important part of their national patrimony. But the country’s oil production has fallen in recent years, as the giant Cantarell field is in decline and a mismanaged and cash-poor Pemex, Mexico’s national oil company, has not invested enough to make up for the loss.
Since the reforms, the Mexican government has entered into oil and gas exploration contracts with nearly 80 companies. Contracts already in place under the reforms could yield $200 billion in investments in Mexico’s energy sector in the coming years. These investments will benefit Mexico’s economy and its people, but these benefits will take time to appear. Politicians and energy investments operate on different timeframes, and Peña Nieto will not see the fruits of his reform within his term.
In the meantime, Mexican citizens are skeptical of the reforms and most concerned about pocketbook issues—the prices for gasoline and electricity that they pay every day—as my Brookings colleagues recently explored in an excellent paper.
Will López Obrador retain the reforms?
In the past, President-elect López Obrador was strongly opposed to the energy reforms. In 2014, he led an effort to hold a binding national referendum to abolish the reforms, but the supreme court blocked the effort. Completely reversing the reforms would be another change to the constitution, requiring a two-thirds vote from both houses of congress and approval from a majority of the 32 state legislatures.
López Obrador has softened his opinion of the reforms since then. He has pulled back his promise to reverse them, instead stating that he will review all contracts established under the reforms to ensure that they are in Mexico’s national interest. Just before the election, his business advisor Alfonso Romo said that López Obrador was open to more contracts for oil and gas exploration if the process was not tainted by corruption. Romo also said that he was comfortable with the contracts that he had reviewed thus far.
Uncertainty is the biggest challenge to investment in Mexico’s oil and gas sector today.
Despite these reassurances, uncertainty is the biggest challenge to investment in Mexico’s oil and gas sector today. As López Obrador makes the transition from campaigning to governing, he will face pressures from many directions. It remains to be seen how he will balance business interests and economic growth against the demands of his populist base. The process of reviewing contracts for oil and gas development introduces uncertainty—López Obrador could bring the auction process for new exploration to a halt without changing any laws or the constitution, just by making the process too risky for investors.
López Obrador has other plans that could be ... By Samantha Gross
Mexicans, frustrated with years of increasing violence and corruption and sluggish economic growth, elected a new president on Sunday. Andrés Manuel López Obrador is a charismatic populist who won the presidency in a ...